How Does Bankruptcy Affect a Promissory Note?

Promissory Notes Are Legally Binding

A promissory note or promissory letter is a legally binding document that obligates an individual or organization to pay another individual or organization a certain amount of money in a certain amount of time. While nearly all types of loans are considered a legal promissory note of one type or another, the question of whether or not an actual promissory note put together by individuals is affected during a bankruptcy is often a confusing topic of conversation.

The Legal Status of Personal Promissory Notes

Personal promissory notes are often considered by many as simple IOUs. Personal promissory notes do not receive the same recognition as a credit card agreement or a mortgage note because people believe them to be informal agreements that are merely documented on paper. Nothing could actually be further from the truth.

The Legal Status of a Signed Promissory Note

A signed promissory note or promissory letter, regardless of the amount of money borrowed or the terms of repayment of the borrowed money, is just as legally binding and enforceable as a mortgage note on an expensive home.

Promissory Notes Hold the Same Value as Other Debts

The terms and values of a legal promissory note are not of consequence when it comes to the enforcement of the note. In the eyes of the law, all promissory notes that are entered into legally are considered the same. Thus, if an individual who has signed a personal promissory note with another individual enters into bankruptcy, that promissory note becomes part of the individual’s personal liability. This means that any money due according to the promissory note is stayed under the terms of the bankruptcy court.

Chapter 7 Removes the Debtor's Liability

Depending on the type of bankruptcy, the note can be resolved in one of two ways:

• Chapter 7 bankruptcy
• Chapter 13 bankruptcy

In Chapter 7 bankruptcy, all personal liability for repayment of the promissory note is removed and the individual no longer has a legal obligation to repay the note. In this case, the individual can agree to repay the note after the bankruptcy if the promissory note was between themselves and a friend, but they are not legally bound to do so.

Chapter 13 Restructures the Promissory Note Repayment

In Chapter 13 bankruptcy, the bankruptcy court consolidates all of the debts into one monthly payment which the court disperses to the proper debtors every month. In this process, the holder of the promissory note will receive repayment for the note but not under the original terms of the legal promissory note itself.

Tangible Assets Acquired with the Promissory Note Can Be Repossessed

It is important to note that if the original promissory note was for the purchase of an item that acted as security on the note, such as a car or motorcycle, the note holder can repossess the item, even though the bankruptcy removed the personal liability on the original loan. If this is the case, the individual can make arrangements to continue paying for the vehicle outside of the bankruptcy judgment to prevent losing the vehicle to repossession.

How to Create a Promissory Note

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